Airline stocks, including Air Canada (TSX:AC), have trailed the broader markets since the onset of the COVID-19 pandemic. The capital-intensive nature of the airline sector forced Air Canada and its peers to raise debt amid global lockdowns as revenues nosedived. While the dreaded pandemic was brought under control, airline companies soon wrestled with multiple headwinds, such as inflation, rising fuel prices, elevated interest rates, and slowing consumer spending.
Today, valued at a market cap of $5.68 billion, Air Canada stock trades 70% below all-time highs. Let’s see if it makes sense to invest in this beaten-down airline giant right now.
Why is Air Canada stock underperforming?
In the last 12 months, Air Canada has reported revenue of $20.75 billion, an increase of 9.6% year over year. Before Covid, its sales stood at $17.94 billion in 2019, an annual record for the company.
While its sales have improved in the last five years, growth in Air Canada’s earnings before tax has been marginal, at $1.79 billion last year, up from $1.77 billion in 2019.
The key reason for this tepid growth can be attributed to higher interest expenses, which have risen from $480 million in 2019 to $839 million in the last 12 months. Moreover, its free cash flow has fallen from $3.68 billion to $2.31 billion in this period.
Air Canada ended the second quarter (Q2) of 2024 with a total long-term debt of $8.9 billion, up from $5.2 billion in 2019. While its debt levels have surged, investors should note that the company has used its free cash flow to reduce its long-term debt by $3.6 billion over the last 18 months.
Is the worst over for Air Canada stock?
The Bank of Canada has lowered interest rates by 75 basis points over the last three months. With further interest rate cuts on the horizon, Air Canada should benefit from lower interest expenses and widening profit margins.
Next, jet fuel prices account for a substantial portion of airline expenses. In the last 12 months, they have fallen by 21.2% year over year, which should also boost the bottom line.
Finally, Air Canada recently avoided a shutdown after it reached a four-year deal with pilots. While the deal terms are confidential, a final agreement will be reached within the next month.
What is the target price for Air Canada stock?
Air Canada stock is priced at less than three times trailing free cash flow, making it among the cheapest stocks on the TSX. Analysts tracking the airline stock expect adjusted earnings to expand from $2.43 per share in 2024 to $2.74 per share in 2025. So, priced at 6.5 times forward earnings, Air Canada stock has significant upside potential if travel demand remains robust amid falling jet fuel prices and lower interest expenses.
Out of the 16 analysts tracking Air Canada stock, 13 recommend “buy” and three recommend “hold.” Notably, there are no sell recommendations for the TSX stock. The average 12-month target price for Air Canada stock is $22, indicating an upside potential of 34% from current levels.
